Full steam ahead on interest rate rises

Yesterday's OCR lift to 2.75pc just the start with April, June and July rises tipped.

Reserve Bank governor Graeme Wheeler has signalled an aggressive, front-loaded start to the interest rate cycle now under way.

He delivered the rise he had all but promised in the official cash rate from 2.5 to 2.75 per cent yesterday and indicated that the only question in the bank's mind at this stage - if the facts change it will change its mind - is whether there will be another three or four similar increases by the end of the year.

The interest rate projections the monetary policy statement has pencilled in suggest further OCR hikes April, June and July.

That is what the economists at the BNZ and Westpac expect him to do. ANZ is picking April and June, with a risk of another in July, as does Deutsche Bank with the caveat around a July move being whether it has started to look by then that 100 basis points this year will be enough. ASB is picking OCR hikes in April and July, but a pause in June.

Looking further out - where there is more uncertainty around such projections - the bank is foreshadowing a cumulative 200 basis points of tightening by the end of next year and another 50 points in 2016, by which point monetary policy will have veered from tailwind to headwind.

BNZ head of research Stephen Toplis supports the central bank's approach to signalling its intentions.

"If a central bank is going to commence a tightening cycle it has to give a clear message that it means business and will do whatever it takes to ensure the economy is managed into a non-inflationary state," Toplis said. "Wheeler has given the clear message that interest rates will simply keep on rising until such time that the economy and its participants behave."

Toplis contrasted this with the approach of previous governor Alan Bollard who had been "almost apologetic" when raising rates and created the perception rate hikes would stop after each move higher.

"We believe this was one of the reason why ultimately rates had to go as high as they did."

The more dovish reaction from ASB's chief economist Nick Tuffley put more weight on the caveats the Reserve Bank has attached to its guidance.

In particular the bank said it would carefully watch how households responded to higher rates - something they have not seen since 2007, apart from two increases in 2010 which were promptly reversed after the February 2011 earthquake.

A key difference between then and now is that this time nearly three-quarters of the mortgage debt is at floating rates or fixed for less than a year.

"We are all essentially lab rats in an economic experiment," Tuffley said. "Collectively our borrowing appetites and consumer behaviour are likely to be more sensitive than they used to be to higher interest rates - but just how much remains to be seen."

Other key assumptions the bank is making, and will need to keep reassessing, are that the spillover of inflationary pressure of the Canterbury rebuild to other sectors and regions will be limited, that most of the rapid increase in net immigration is behind us and so is the peak in house price inflation.

The bank's projections hold out no prospect of relief from the high dollar this year. It points to the strong correlation since 2000 between the trade-weighted exchange rate and the terms of trade, now at a 40-year high.

"Rising interest rates, a projected easing in migration flows and the increase in housing supply should reduce the imbalances in the housing market and moderate price pressures."

Reserve Bank governor Graeme Wheeler

New Zealand is the first advanced economy to raise its policy interest rate since the global financial crisis, while countries which account for two-thirds of world output have policy rates between 0 and 1 per cent and are not expected to raise them any time soon.

But when asked about the risk that he would push the currency higher still, Wheeler said, "The exchange rate pressures are a concern for us but we also feel we have telegraphed these moves quite carefully. So I don't think it is any surprise to the market, and institutional investors are anticipating this sort of tightening. Therefore we are not expecting to see any significant exchange rate increases as a result."

Westpac chief economist Dominick Stephens said that before yesterday's statement financial markets were not completely sold on the case for five OCR hikes this year.

"So wholesale interest rates and the NZ dollar rose slightly in response. The muted market response will give the Reserve Bank some comfort that it can indeed 'go it alone' on interest rate hikes without the risk of driving the currency ever higher."

Loan curbs paying off

The Reserve Bank says its curbs on low-deposit mortgage lending are working as intended and that house price inflation would be 2.5 percentage points higher without them.

"On a monthly seasonally adjusted basis house sales are down 13 per cent since September, and down 15 per cent in Auckland," governor Graeme Wheeler said.

"We are all essentially lab rats in an economic experiment. Collectively our borrowing appetites and consumer behaviour are likely to be more sensitive than they used to be to higher interest rates - but just how much remains to be seen."

ASB Bank chief economist Nick Tuffley

"And if you look at the seasonally adjusted Real Estate Institute stratified house price index, house prices for the last four months are up 1 per cent. The four months before that they were up 4 per cent. So we are seeing a reduction in house sales and some moderation in house price inflation."

The bank did some modelling to estimate the counterfactual - what would have been the effect on house price inflation if it had not introduced last October restrictions on lending at loan-to-value ratios (LVRs) above 80 per cent.

"If the banks were [still] lending 25 to 30 per cent of their mortgages to high LVR borrowers instead of the current 6 or 7 per cent, what would house price inflation be doing nationally?

"House price inflation is currently running around 8.4 per cent. We think it would have been 2.5 per cent on top of that, in other words around 11 per cent," Wheeler said.

MPSmar14 (PDF)MPSmar14 (Text)When it introduced the regime the Reserve Bank said it expected the LVR curbs would shave between 1 and 4 percentage points off house price inflation in its first year. It still thinks so.

"However, the recent weakness in housing market data suggests the impact of the LVR policy may be more front-loaded."

It expects the proportion of new lending on high LVRs to rise closer to its 10 per cent limit as banks get more accustomed to the regime, "possibly with a little buffer".

It believes the peak in quarterly house price inflation is behind us.

"Rising interest rates, a projected easing in migration flows and the increase in housing supply should reduce the imbalances in the housing market and moderate price pressures."

But Wheeler told MPs on the finance and expenditure select committee that while building consent issues had risen in Auckland "we need to see a stronger supply response".